Private Credit: A Strategic Allocation for Enhanced Portfolio Resilience
Private credit has emerged as a significant alternative investment asset class, attracting investors seeking to enhance portfolio diversification while achieving attractive risk-adjusted returns. As market dynamics continue to evolve, incorporating private credit into a broader investment strategy can provide a compelling solution for investors focused on yield enhancement, downside protection, and/or portfolio stability.
Defining Private Credit
Private credit encompasses non-publicly traded loans originated by non-bank lenders. These loans are generally bespoke, tailored to meet the specific financing needs of borrowers, and typically offer investors higher yields relative to public fixed-income investments. Private credit strategies include, but are not limited to, senior direct lending, subordinated debt, distressed debt, asset-based lending, and specialty finance. While these categories serve as the core framework for the asset class, the private credit universe is continually evolving, offering new opportunities for investors as market conditions change.
The typical borrower profile, in a private credit transaction, is a U.S. middle market firm with annual revenues between $10 million and $1 billion.1 Larger corporations have also started to tap the private credit market because of the speed of execution and the high degree of loan customization providing the borrower with a competitive advantage in the marketplace. This illustrates the evolving nature and sophistication of non-bank lenders and their ability to provide financing solutions for both small and large U.S. companies.
Growth and Market Dynamics
As of June 30, 2024, private credit represented approximately 9.3% of the $17.2 trillion alternative investment market, totaling $1.6 trillion in assets under management (AUM). This segment has seen substantial growth, more than doubling in size since 2018.2 Contributing factors include borrower preferences for non-bank financing, regulatory changes that have created a favorable environment for alternative lenders, and a shift in risk appetite among traditional banking institutions. Looking ahead, private credit AUM is expected to reach $3.0 trillion by 2029, supported by continued investor demand and the asset class’s ability to deliver customized lending solutions that meet the evolving needs of borrowers.
Source: iCapital, as of 2Q 2025
Strategic Benefits of Private Credit
For investors, private credit offers a range of potential benefits, most notably in its ability to provide diversification, enhanced yields, and reduced correlation with broader public markets. The customization inherent in private credit transactions, which are structured to align with the specific requirements of borrowers, results in investments that often exhibit low correlation to traditional asset classes, making them an attractive option in volatile or uncertain market conditions. Additionally, private credit can serve as an effective tool for achieving income generation, particularly for those investors with an acceptable tolerance for risk and illiquidity.
From a yield perspective, private credit remains highly compelling relative to other fixed income categories. For example, private credit is projected to generate a net adjusted yield of approximately 10.0% on a go forward basis.3 This significantly surpasses the starting yields of other fixed income assets such as U.S. high yield (7.7%), investment grade (5.2%), and U.S. Treasuries (4.1%).4 The higher starting yield of private credit reflects its ability to provide higher relative returns, driven by the direct relationship between lenders and borrowers, which often results in better risk-adjusted returns. Additionally, private credit typically involves tighter underwriting standards and covenants, offering enhanced protection for lenders and investors.
Source: Cliffwater
Source: JPMorgan, Guide to the Markets
Risk Mitigation and Capital Structure Positioning
One of the defining characteristics of private credit is its position within the capital stack or enterprise value of a company.5 Typically senior in the capital stack, private credit loans are structured to offer a degree of downside protection in the event of borrower distress, such as default or bankruptcy. Additionally, many private credit transactions are secured by collateral, providing investors with an additional layer of protection. Rigorous underwriting processes, including extensive due diligence, are standard practice, and loan covenants are often incorporated to ensure that borrowers adhere to agreed-upon financial and operational metrics. These covenants help mitigate risk by providing lenders with early warning signals and enabling intervention before a default occurs.
Of course, not everything goes according to plan and in terms of default rates, private credit has proven to be a relatively stable asset class. Over the past decade private credit’s annualized loss rates have averaged 1.0%, significantly lower than the 2.0%+ loss rates observed in commercial bank loans.6 This risk mitigation is especially noteworthy given the perceived higher risk associated with private credit investments.
The Borrower’s Perspective: Why Choose Private Credit?
Borrowers increasingly seek private credit solutions due to the flexibility, speed, and customization that non-bank lenders can provide. Compared to traditional bank financing, private credit typically provides tailored loan terms, allowing borrowers to address specific capital needs in a timely manner. Non-bank lenders are also able to expedite the approval process, making private credit an attractive option for companies requiring immediate access to capital. Moreover, non-bank lenders often have deep expertise in particular industries, enabling them to form collaborative relationships with borrowers that can generate additional value. The regulatory flexibility enjoyed by non-bank lenders further accelerates the lending process, making private credit an efficient financing solution.
Outlook and Conclusion
The outlook for private credit remains robust. As the asset class continues to evolve, it offers attractive opportunities for investors looking to diversify their portfolios, generate stable income, and protect against downside risks. Understanding the complexities of private credit is critical for investors seeking to incorporate this asset class into their investment strategy. Selecting the right investment manager with a proven track record is essential for unlocking the full potential of private credit investments. Given its ability to provide attractive yields, downside protection, and low correlation to broader markets, private credit has become an essential component of investment portfolios aiming to meet long-term financial planning goals.
1 Federal Reserve, Private Credit: Characteristics and Risks, February 23, 2024.
2 iCapital, Alternatives Decoded, Q2 2025.
3 Cliffwater, Direct Leding for the Long Run, June 2024. 10% Yield = 3.0% SOFR +3.6% credit spread on non-investment grade credit + 0.9% Originator Discount +3.5% illiquidity premium – 1.0% from losses from direct lending.
4 Yields as of 3/31/2025. Yield-to-Worst used for U.S. treasuries, investment grade, and U.S. high yield.
5 Illustrative Capital Stack from KKR
6 Loss rates for private credit based on Cliffwater Index. Loss rate for commercial bank loans based on Federal Reserve Data. Loss rates annualized from 2005-2023.
Author:
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Robert C. Lopez, CFA and CAIA® Vice President, Portfolio Manager, Principal Investment Analyst First American Trust |
Robert brings more than 17 years of experience in wealth planning and investment management to his role as Portfolio Manager and Principal Investment Analyst.
As a Portfolio Manager, he works closely with clients to understand their investment goals, cash flow needs, and risk tolerance to tailor an investment portfolio to meet their financial planning goals. Robert has a passion for client service and is always happy to discuss economic and investment conditions in greater detail to drive sound investment decisions. Robert also leads the alternative investments platform, which includes selecting investment managers that specialize in real estate, private credit, and private equity with the goal of delivering attractive risk-adjusted returns.
The following article is for informational purposes only and is not and may not be construed as legal, tax and/or investment advice. Investments contain risks, no third-party entity may rely upon anything contained herein when making legal, tax and/or investment determinations regarding its practices, and such third party should consult with an attorney, tax advisor and/or an investment professional prior to embarking upon any specific course of action.
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